The cash is a very important entity to any company. It is the key focus that determines whether a company should continue operating or not. The cash includes currency, checks on hand and deposits in banks this can also be either be short-term or temporary investments. The cash that is obtained is used in payment of expenses and still used to generate more cash. All these transactions are recorded in statement of cash flows which reports the sources and uses of cash (IBM, 2004). What is a statement of cash flows? Importance of cash flow to successful management of projects, what information does it provide?
What are the major sections of the statement and what is included in each section? Statement of Cash Flows Definition A statement of cash flows is a document that examines how cash has entered and left the financial life of any business during the year, it helps in showing the financial strengths and weaknesses. It is prepared from a good balance sheet prepared at the beginning and end of the year, the manager must also have an accrual adjusted Income Statement for the year. The statement shows the beginning cash balance which is the cash and account balances that appear on the balance sheet from the beginning of the year.
(Kurtz, 2007, pp 1-2). Importance of the Cash flow Statement The statement discloses how the business project raises money and how it spends the funds during a given period. It measures and analyses the projects ability to cover its expenses within a given period of time. It is very important as a manager to understand the cash flow statement in order to reveal important aspect of business responsibilities. The income statement might report high profits for any year of which still there may be problems with cash, since it doesn’t distinguish cash from credit transaction. This can only be revealed in cash flow statement.
It also enables easy comprehensive report that helps in keeping track of all the company’s cash transactions (Cogan, 1996) Major Sections The statement of cash flows is divided into three sections. These sections include; Cash from Operating Activities, Cash from Investing Activities and Cash from Financing Activities, these are all added up to produce the ‘Net Change in Cash Balance’ which is then added to the beginning cash balance to produce the ending cash balance. The first section cash from operating activities deals with the cash that comes from project income and non-project income.
This same cash leaves the business through payment of project expenses, income tax and social security tax. These uses and sources are all added up to produce cash from operations (Kurtz, 2007, pp 1-2) The second section identifies Cash from Investing Activities. This is where the cash is generated from the sale of assets, which is then used in the purchase of other assets. This section accounts for cash used in making new companies investments as well as gaining from previous investments (Richards, 2008). The manager hence must invest in assets which are expensive, so that by the time of their disposal many are old and of little value.
The total can only be contributing cash when it is positive. (Kurtz, 2007, pp 1-2) The third section identifies the Cash from Financing Activities. The cash is generated from taking on loan or issuing stock to new investors and used up in the repayment of principal. It also shows the inflows from gifts and inheritances received and outflows from the given cash. Dividends to the current investors are also recorded here. All these sources and uses are totaled up to produce the Cash from Financing Activities (Kurtz, 2007, pp 1-2). Methods of calculating project cash flows Direct Method
This entails the basic analysis of the cash and bank accounts in order to identify the cash flows during the given period. The general ledger report or the cash receipts and disbursement journals can be used to determine the starting entry for each cash entry, and this shows the place of entry of each cash movement on the cash flow statement. The other way of determination of the cash flows under this method, is through the worksheet preparation for each major item and this eliminates the effects of accrual basis accounting in order to get net cash for the same line item in a given period (Kmhagen, 2005, pp 1-3)
Under the direct method the following are some of the sample that is reported in the cash flows from the operating activities section of the cash flow statement; Cash receipt from customers; Net sales+ beginning balance- ending balance in accounts receivables = cash receipts from customers, cash payments for inventory; Ending inventory – beginning inventory + ending bal. in accounts payable to vendors – ending balance in accounts payable for vendors, Cash paid to the employees; salaries & wages as per income statement + payable beginning balance – payable ending balance,
Cash paid for operating expenses, taxes paid, Interest paid, equals net cash provided by (used in) operating activities (Kmhagen, 2005, pp 1-3) Indirect Method This method generally analyzes the income and expense accounts including the working capital. In this method, the preparation of cash flows from operating activities start with net income per the income statement. All the entries that does not involve cash movement and show changes in net working capital are reversed to income and expense accounts.
The income that has been earned but not yet received, accrued and prepaid expenses and depreciation, all affect net income but do not represent cash flows. (Kmhagen, 2005, pp 1-3) The following example illustrates how the method is presented on the cash flow statement; (Net income per the income statement – entries to income accounts not representing cash flows) + Entries to expense accounts not representing cash flows = Cash flows before movements in working capital Add or less the change in working capital, which is as follows;
Increase in current assets is shown as a negative figure, since cash is spent or converted into other current assets, reducing the cash balance. Decrease in current assets is shown as positive figure since other current assets are converted into cash Increase in current liabilities excluding short-term debts, would be shown as positive figure, since cash is spent to reduce liabilities The overall net effect of the illustration is then recorded as cash used in operating activities (Kmhagen, 2005, pp 1-3) References Coggan, D. A. (1996). Sample Cash Flow Statement.
Retrieved 28th October 2008 from http://www. coggan. com/ IBM Annual Report, (2004). Guide to understanding basic financials. Retrieved 28th October 2008 from http://www. ibm. com/ Kmhagen, (2005). How to prepare a Cash Flow Statement. Retrieved 28th October 2008 From http://www. GoogoBits. com/ Kurtz, J. N. , (2007). Statement of Cash Flows. Retrieved 28th October 2008 From http://www. extension. umn. edu/distribution/businessmanagement/components/M1217-4. pdf Richards, D. (2008). Interpreting the Cash Flow Statement. Retrieved 28th October 2008 From http://www. About. com/